A sole proprietorship is the easiest type of business to open. There is no separate legal entity formed when you create a sole proprietorship for your business. This means the owner of the business is the one who is responsible for all its debts and actions. You are allowed to create a separate name for your business, despite all the responsibility falling on the owner. This business name is called a DBA in the United States, which stands for "Doing Business As". This is only a name you would use for commercial and advertising purposes but it would still not be a separate legal entity. Any liabilities you incur under the DBA will be your own personal liabilities.
A lot of entrepreneurs like to create sole proprietorships because they are cheap to create and easy to establish. Not only that, a lot of investors like to purchase sole proprietorship businesses because they are only purchasing the assets of the business. This means there are less legal issues involved during the sales process. If you are a sole proprietorship who has some value in their business, you might be confused about how to sell the business because there is no separate legal entity. The specifics of the sales process will be discussed now.
What Can a Sole Proprietorship Sell or Transfer?
Since a sole proprietorship represents the owner of the business, you cannot actually transfer a sole proprietorship to someone else. All the legal obligations and debts that you’ve undertaken throughout the operation of the business will remain with you and cannot be transferred to someone else. However, you are able to sell and transfer the assets of the business to a new owner. These can be tangible assets, intangible assets, or both. But before the new owner can acquire these assets, they must set up their own unique business structure first. This could be a sole proprietorship of their own or another business entity type, like a Limited Liability Company. Once they have created their own business structure, the sales transaction for the assets can begin.
Remember that tangible assets refer to all physical assets, such as inventory, supplies, land, buildings, and machinery. Intangible assets refer to intellectual properties that are not physical such as trademarks, patents, copyrights, and brand names. It is up to you to decide which of these assets you want to sell. But if you’re looking to sell your business and you want to set the highest asking price possible, then you’ll want to include all the assets you have for the business so that it looks more attractive to potential buyers.
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Valuation of a Sole Proprietorship
The value of your sole proprietorship is determined by finding the value of your business’ assets and the total of its annual earnings. A quick way to make this calculation is to take the total annual earnings of the business and multiply it by 5. This will just give you a rough estimate of what it’s worth but you don’t want to solely rely on this figure. You need to first go through all your assets and determine what each one is worth. Asset valuation is very important because your buyer is only going to be buying your assets. The annual earnings just show the potential of your business model and how it makes money with the assets that you’re using with it. The idea is that once they purchase these assets and learn your business model, they will likely be able to make the same annual earnings once they start using these assets with their own business.
Related: Earnings-based Business Valuation Tool
To figure out the value of tangible assets, you simply must look at their market values. Real estate, for example, is easy to value because your local county already sets a market value for your property. Physical items like inventory can be valued based on their current wholesale price. As for intangible assets, these are valued based on how much money they make your business. If you own a brand that has recognition from a loyal customer base, the amount of annual earnings this brand generates will determine its worth. The value of your brand and its customer base is referred to as "goodwill".
Your customer list is the most valuable intangible asset of your business, whether it’s connected to a brand or not. A customer list is like gold to your buyer because they can just take that list and continue selling the same products and services to them that you were selling. This is like a guarantee to your buyer that they’ll be able to take your assets and make money right away with them because they already have the list of customers who want to buy them.
The Business Sale Agreement
When you sell a sole proprietorship, a Business Sale Agreement is critical to use for the transaction. This agreement needs to highlight all the assets that are being transferred with the sale of the business. It should also list any other stipulations that pertain to the operation of the business after the assets are transferred. For example, a non-compete agreement is often used in conjunction with a Business Sale Agreement. This non-compete agreement gives the buyer protection by assuring them that you aren’t going to operate a similar business within the same location and using the same customers. On the other hand, this agreement could give you the right to keep your existing clients because they have already developed a working relationship with you. Whichever way you want it, the specifics of who gets the customer lists needs to be addressed.
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Aside from the intangible assets, you need to list all the tangible assets in the Business Sale Agreement. This means every piece of inventory, machinery, real estate, and other property that you want to include. In some circumstances, you may want to include a provision in the agreement where you offer training to the buyer. That way, they will know how to run their new business just like you ran your sole proprietorship. Of course, offering this training to your buyer is optional but it would certainly be a nice incentive to get them to purchase your business assets.
As for liabilities, these usually stay with the seller of the sole proprietorship. Buyers typically want to see in writing that they will not be responsible for any existing debts that were accumulated by the owner. This is particularly important for when buyers end up requesting credit for the business. In order to avoid confusion, they need to be able to provide a Business Sale Agreement to the lender which outlines that they are not the ones who owe this debt.
The Handling of Debts
As the seller, you will have to pay back all the money that you owe. This could be money you owe to banks, suppliers, or other creditors. The sale of your business is not going to change this fact. If you do not pay back your debts, these lenders could end up suing you personally in civil court which will ultimately affect your personal credit rating. This is the biggest downside to sole proprietorships because the creditors cannot go after a separate business entity. They will only go after the owner. Sometimes the creditors will try to levy your business profits or go after the money you made from the sale of your business so they can get paid back.
The only good news is that the debts and liabilities have no effect on the buyer. So, even if you owe a lot of money to creditors, you can still proceed with the sale of your business and not have to worry about clearing the debts first. Most owners will use the proceeds from the sale of their business to pay back the creditors, though. You can choose to do this if you want to but it is not required when selling a sole proprietorship.
Video: Find out about liability after the selling of a sole proprietorship. By Isaac Rodriguez, an expert.
Due Diligence
One thing that sellers will usually require buyers to do is due diligence. This means they must do their own research into the business itself to determine its value. The seller can provide documentation and details about the business, of course, but the buyer is not supposed to take it at face value. They are required to verify the accuracy of this information by investigating it themselves. This is another stipulation that is often stated in the Business Sale Agreement.
With that being said, there are a few complications when buyers do their due diligence. For starters, the owner does not file a commercial tax return because the business is under their own name. This means they list the business’ income on the Schedule C form of their personal tax return. Therefore, you would have to provide your personal tax return to the buyer in order for them to see its income. Also, when the buyer goes to the local courthouse and conducts searches for judgments and liens on the business, they will have to search for your personal name and the DBA name of the business. This will make the search more difficult for them because they will have to separate any personal liens that have been filed against you from the liens filed against the business. Since both are likely under your name, this will require them to conduct more searches. If they are paying a third-party company to help them with this, then it means they will be paying more money to do this.
You might wonder why the buyer would care about the liens if they are in your name. Well, they may want to compare their research to what is listed for liabilities in the Business Sale Agreement. If the agreement were to fail to mention the existing liens as being the responsibility of the seller, the creditors may mistakenly come after them. This is especially true if the liens are under the DBA company name.
Closing the Sale
Once the Business Sale Agreement has been signed by both parties, the true closing of the sale can begin. This involves handing over all the tangible assets to the buyer and transferring all the intangible assets to them as well. If cars or real estate assets were included in the sale, you need to sign over the deed or title paperwork to the buyer so they can take over ownership of them. As for other things like tax identification numbers and the DBA business name, these are not transferable with the sale of a sole proprietorship. You must basically dissolve each of these things. For the tax identification number, you need to contact the Internal Revenue Service and tell them you’re closing your company so they can dissolve the number. Then, you need to conduct your Secretary of State’s office and file dissolution paperwork to dissolve the business and its DBA company name. Remember that any brand names you sold for the business need to be transferred through the U.S. Patent and Trademark Office.
Tax Implications
Lastly, the sale of your sole proprietorship will come with certain tax implications. Since you are only selling assets from your business, you must list them as capital gains on the Schedule D form of your personal tax return. The capital gains tax rate can be as high as 23.8% depending on how much net profit you made from the sale of the assets. Unfortunately, most of the money you receive from the sale will likely get taxed. When you go to list how much money you paid for the assets on your tax return, the Internal Revenue Service does not factor in the cost associated with intangible assets. They will only consider the money paid for tangible assets. For example, let’s say your business consists of $1,000 in inventory, a $500 laptop, and a customer list worth $10,000. If you sold your business for $9,000, then the Internal Revenue Service will tax $7,500 of that amount because it only subtracts the cost of the laptop and inventory from the sale amount. As a result, you will pay more money in taxes.
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